More soft data propel Treasurys

Jobs report reveals feeble growth

By

JulieRannazzisi

NEW YORK (CBS.MW) -- Treasury prices staged a massive rally Friday as a weaker-than-expected jobs report provided fodder to those expecting more Fed rate cuts. The yield on a bellwether 10-year note remains at its lowest level since mid November.

Nonfarm payrolls rose a meager 6,000 in July vs. the 80,000 increase that had been predicted by economists. The unemployment rate was steady, as expected, at a 5.9 percent rate. June job growth was upwardly revised to 66,000 from 36,000.

In another negative sign, hours worked fell in July, as did the average workweek. Average hourly earnings rose 0.3 percent. See full story.

In other news, July personal income climbed 0.6 percent, more than the 0.4 percent that had been expected. And personal consumption expenditures climbed by 0.5 percent, a touch less than the 0.6 percent increase that had been expected.

In the currency sector, the dollar edged down 0.3 percent to 118.82 yen while the euro rose 0.2 percent to 98.62 cents.

The dollar has held up remarkably well this week in the face of soft economic news.

Stocks ended sharply lower, unable to shake off fears that the economy may be falling back into recession. The Dow Jones Industrial Average
DJIA, -0.67%
tumbled 193 points, or 2.3 percent, to 8,313 and the Nasdaq Composite
$COMPQ
slumped 32 points, or 2.5 percent, to 1,247. See full story.

The 'double dip' debate

This week's litany of soft numbers brought up the "double-dip" theory -- or a fall back into recession -- with a vengeance.

Ethan Harris, economist at Lehman Brothers, said the jobs report was not unremittingly bad -- he believes there were some encouraging nuggets -- but added that the drop in the workweek should not be ignored.

"It's more than just statistical noise. You can't underestimate the effect it will have on production," Harris said.

What rendered Friday's number so discouraging, Harris said, was that it topped off a week of glum economic news. If the market gets two straight months of weak employment reports and soft retail sales numbers, the economist feels the Fed will pull the ease trigger.

"What stopped the solid economic momentum in its tracks? The only explanation is that the equity markets problems caused businesses to fear a slowing in consumer spending and so they hired more cautiously. Is a double-dip in the cards? Only if the stock markets do not stabilize and consumers do get cautious," surmised Joel Naroff, chief economist at Naroff Economic Advisors.

Harris said the collateral damage of the market's two-month plunge is now hitting the economic stats --just as stocks are attempting to regain their footing.

"This makes it harder for stocks to recover. It's not a good dynamic." Harris noted.

A Fed rate cut priced in

This week's rash of soft data have considerably increased the odds of a Fed rate cut over the past few sessions.

Harris feels the markets are "under predicting" the possibility of Fed rate cuts.

Harris assigns a 45-percent chance to rate cuts over the next several months. And if the Fed does ease, the economist said it would likely be by at least 50 basis points in total -- probably distributed over two FOMC meetings.

Goldman Sachs economists lowered their growth and fed funds rate forecasts for the year due to weak factory goods orders, setbacks in construction and persistent stagnation in new hiring.

Goldman now expects real GDP to rise only 2 percent in the fourth quarter and in the first quarter of 2003, down from previous forecasts of 2.50 percent and 2.74 percent, respectively.

Goldman reduced 2003 growth estimates to 2.3 percent or 2.4 percent from the previous 2.8 percent. While Goldman said it is not predicting a double dip scenario to play out, it acknowledged that the probability is rising.

Goldman Sachs economists now expect the Fed to slash rates by 75 basis points in the fourth quarter to take the fed funds rate to 1 percent by year-end.

The December fed funds futures contract is currently factoring in a 1.50 percent overnight rate -- signaling near certainty on the market's part that the Fed will lop off 25 basis points from short rates by year-end. That compares to a less than 60 percent chance just a couple of days ago and is a huge change from the market's expectations a month ago.

In the final trading session of June, in fact, fed funds futures traders were putting the odds of a 1/4- point rate hike at around 80 percent. And earlier in the year, market participants were factoring in three to four Fed rates increases of 25 basis points each throughout 2002.

In the same timeframe, the Treasury yield curve -- or the differential between long and short rates -- had widened dramatically, evidencing the growing belief that a lower fed funds rate is in the offing. The yield spread between a 30-year bond and a 2- year note swelled to its widest level in over a decade on Thursday.

A sea change in sentiment has indeed occurred over the past two months, when it became clear that the frenzied pace of growth characteristic of the first quarter was not here to stay.

While growth was expected to taper off once inventory restocking was completed, economists were not banking on such a substantial slowdown. And the stock market nosedive this summer threw another wrench into the whole picture, raising questions over the impact of the negative wealth effect on spending patterns.

Downgrades slip in July: Moody's

While acknowledging that it is still too early to conclude the downgrade-per-upgrade ratio peaked in the second quarter, Moody's said the beneficial effects of more conservative investing and reduced leverage may be starting to materialize.

"The still wide excess of the dollar amount of downgrades over upgrades and a preponderance of downgrade reviews suggest credit risks remain high. Corporate earnings must rebound and the equity market must stabilize to produce a definitive bottom in the credit cycle," Moody's economists wrote in a research note.

July's 2.9 to 1 downgrade-per-upgrade ratio was well below the second quarter's 4.9-to-1, Moody's said, pointing out that monthly changes in the downgrade-per-upgrade ratio can be volatile.

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